In July 2018, the HKEX issued a guidance letter for initial public offering applicants in the internet technology sector or that have internet-based business models (“Applicant(s)”).

High Degree of Reliance

Main Board Rule 8.04 states that both the issuer and its business must, in the opinion of The Stock Exchange of Hong Kong Limited (the “Exchange”), be suitable for listing.

Applicants often extensively rely on the businesses of their parent company / connected persons / major suppliers / major customers, to facilitate their own products or services. The Exchange may question the Applicant’s suitability for listing where there is a large degree of reliance.

In assessing whether an Applicant is reliant on a single customer or supplier, the Exchange will consider the list of factors set out in Listing Decision HKEX-LD107-1, which are:   

1. whether the Applicant’s business model can be easily changed to reduce the level of reliance;
2. whether the level of reliance is likely to decrease in the future;
3. whether the whole industry landscape is dominated by a few players making it unlikely for companies in the same line of business to break off the reliance;
4. whether the reliance is mutual and complementary; and
5. whether the Applicant is able to maintain its revenue in the future in light of the reliance.

The Exchange is prepared to accept a higher level of reliance on parent companies / connected persons / major suppliers / major customers in relation to Applicants if the Applicant is able to demonstrate the following characteristics as set out in HKEX-GL97-18:

1. the whole industry landscape is dominated by a few players that may or may not be in the Applicant’s parent company;
2. the services that the Applicant relies on are provided by a small number of dominant major providers in competition with each other;
3. there were legitimate commercial reasons for the Applicant and its parent company (or other connected persons / major suppliers / major customers) to enter into the transactions, and these were on normal commercial terms in the ordinary course of business of the issuer and in the case of transactions with a connected person, be subject to continuing connected transaction requirements under the Listing Rules after listing; and
4. there are long term agreements in place between the Applicant and the parent company (or other connected persons / major suppliers / major customers).

The Applicant would also be required to make a disclosure of the reliance in the listing document.

Quantifying Caps for Continuing Connected Transactions

Main Board Rule 14A.53 states that a listed issuer must set an annual cap for continuing connected transactions.

As stated above, some Applicants extensively rely on the businesses of their parent company or connected persons (together, the “Connected Persons”). In such an instance, the Applicant is required to set a monetary annual cap under the Listing Rules. The Exchange notes that Applicants often structure the payment under the agreement with the Connected Persons as a percentage of the Applicant’s revenue generated through the Connected Person’s product or service. There may be cases in which it is impractical for Applicants to accurately estimate the amount of payment required under the agreement with the Connected Persons where the consideration is based on transaction volume.

The Exchange may grant waivers from strict compliance with the requirement to set a monetary annual cap under The Rules Governing the Listing of Securities on the Stock Exchange (“Listing Rules”) and allow the annual cap to be set as a formula for Applicants. The Applicant would have to demonstrate the necessity for such an arrangement and the formula to be adopted is in line with historical and prevailing commercial practices.

Extensive Use of Share Incentive Schemes

Note 1 to Main Board Rule 17.03(3) states that the total number of securities which may be issued upon exercise of all options to be granted under the share option scheme must not in aggregate exceed 10% of the relevant class of securities of the listed issuer. The note to Main Rule 17.03(4) states that the maximum entitlement of each participant under the share option scheme must not exceed 1% of the relevant class of securities in issue unless separately approved by the shareholders. Main Board Rule 17.03(5) also provides for restrictions for the share option scheme of an Applicant. Main Board Rule 17.03(5) states that the period within which securities must be taken up under the option is limited to ten years from the date of grant of the option.

The Exchange notes that Applicants often retain and incentivise key employees through the grant of share options. The Applicants may find the Listing Rules to be too restrictive to allow them the flexibility to incentivise key employees.

Applicants who demonstrate the necessity for a higher cap / longer option period can apply to the Exchange for a waiver from strict compliance with (i) the percentage cap requirement on outstanding share options under a share option scheme and allow a higher cap to be set; and (ii) the ten year limit within which securities must be taken up under the option and allow a longer period to be set.

Unestablished Regulatory Environment

Applicants often operate in industries for which local laws and regulations are still evolving, and in some instances, are still being drafted. It is difficult for some Applicants to demonstrate that they are in compliance given the evolving regulatory environment in which they operate. The Exchange notes this uncertainty.

If an Applicant’s business is affected by evolving regulations which are still being drafted and are not expected to be promulgated in the near future, the Applicant would normally be expected by the Exchange to disclose of the associated risks in the listing document. 

If it is clear, however, that draft regulations affecting the Applicant’s business will be promulgated in the near future, the Applicant would normally be expected by the Exchange to demonstrate that it is able to comply with the requirements of the draft regulations.

For any enquiries related to this article, please contact Chris Lambert or Warren Ko.